C h a p t e r 1 4 Public Debt - PowerPoint PPT Presentation

C h a p t e r 1 4 Public Debt. The History of U.S. and U.K. Public Debt. The History of U.S. and U.K. Public Debt. The History of U.S. and U.K. Public Debt. Characteristics of Government Bonds. Government bonds pay interest and principal.

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when we combine government and household saving, the change in real government bonds, (Bgt− Bgt−1)/P, cancels out. An increase in real government bonds means that the government is saving less and that households are saving correspondingly more.

What happens in the equilibrium business-cycle model when the government cuts year 1’s real taxes, T1, and runs a budget deficit? Economists often refer to this type of change as a simulative fiscal policy.

Instead of lump-sum taxes, the government levies taxes on labor income. Consider again a reduction in year 1’s real taxes, T1, financed by a budget deficit. We assume that the fall in T1 is accompanied by a decline in the marginal income tax rate, (τw)1.

The increase in (τw)2 lowers labor supply in year 2. This decrease in labor supply leads, when the labor market clears, to a lower quantity of labor, (L2). The reduced labor input leads to a decrease in year 2’s real GDP, Y2.

a budget deficit allows the government to change the timing of labor-income tax rates and thereby alter the timing of labor input and production.

A budget deficit that finances a cut in year 1’s tax rate on labor income motivates a rearrangement of the time pattern of work and production—toward the present (year 1) and away from the future (year 2).

changes in the timing of asset-income tax rates cause changes in the timing of consumption, C, and investment, I. The general point is that, by running budget deficits or surpluses, the government can change the timing of various tax rates. The government can induce changes in the timing of various aspects of economic activity: L, Y, C, and I.

We have found that budget deficits and surpluses allow the government to change the timing of tax rates. However, it would not be a good idea for the government randomly to make tax rates high in some years and low in others.

The public debt has typically been managed to maintain a pattern of reasonably stable tax rates over time. This behavior is called tax-rate smoothing.